To continue from yesterday's post on problems with bringing securities-related lawsuits: In addition to the standing and cause-of-action problems, there are other obstacles peculiar to China and its political situation: specifically, the government's fear and distrust of large groups, especially organized ones, that are not under state control. (All social organizations, for example, must be approved by and registered with the state; even fishing clubs and associations for the study of antique furniture have been disbanded for failure to get official recognition.) Securities litigation, of course, is often possible only if the claims of small shareholders can be aggregated through the class action or some other form of group litigation. While Chinese civil procedure does not provide for class actions in the American sense (where non-participants without notice can be bound by the result), it does provide for various forms of group litigation. But the system makes it difficult for plaintiffs in securities litigation to use these forms.

First, one of the criteria for the professional assessment of Chinese judges is the number of cases they handle. Thus, they have every incentive not to aggregate claims, but rather to disaggregate them. Securities plaintiffs coming to court as one group have on occasion been instructed to split up into several smaller groups - based not on any common characteristics, but simply on numbers.

Second, the system of court fees also contributes to the incentive to split up cases. Court fees are a progressively declining multiple of the amount in controversy: the percentage charged for lower amounts is smaller than the percentage charged for higher amounts. Thus, a court earns more hearing 10 claims of $X than hearing one claim of $10X.

Third, there are two recent rules explicitly aimed at putting the lid on group litigation - probably aimed at social discontent, not securities lawsuits, but nevertheless putting a crimp in the latter. The first rule, issued in the name of the All-China Lawyers Association [PDF here], requires lawyers handling any case involving ten or more plaintiffs to report to the local government for instructions and imposes various other burdens on representation. The second rule, issued in 2006, relaxes the previous (spottily enforced) ban on contingency fees, but keeps it for specific types of cases, including - you guessed it - lawsuits involving multiple plaintiffs (which normally means 10 or more).

Finally, there are special rules governing holders of shares listed on stock exchanges outside the PRC mainland, such as Hong Kong and New York. The China Securities Regulatory Commission requires Chinese companies listing outside of China to include in their articles of association a provision stating that all disputes between holders of non-mainland-listed shares and the company or its high-level management shall be resolved through arbitration. Interestingly, this may well have been intended as a shareholder-friendly measure, on the theory often held in Chinese officialdom that you should require people to do what you think is good for them. We don't see such arbitration clauses in the certificates of incorporation or bylaws of American public companies, and (perhaps because nobody wants to be a test case) it's not at all clear that a federal court would accept such a clause as valid grounds for dismissal of a claim arising out of federal securities law. (My information may be out of date or just wrong; I'm interested in this question, so please add a comment if you know something to the contrary.) But there is little doubt it would be effective in China. Interestingly, this arbitration clause does appear in Article 181 of the Articles of Association of PetroChina, a Chinese company listed (among other places) on the New York Stock Exchange. Do investors generally know it's there? Did the SEC? Does anyone care?

Bottom line: don't look to the Chinese legal system to protect your interests as a small shareholder. (The story is a bit better for holders of significant minority stakes.) There are, of course, other institutions out there that might do the job: for example, equity markets, banks, various gatekeepers, and the financial press. In China I don't think they do the job very well. But that's exactly the paper I'm working on now, and it's a lot more than can be contained in a blog entry.

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In my first post, I mentioned that one question one must always ask about corporate governance rules in Chinese law is: do they matter? One reason the rules often don't matter is because there is no practical method of enforcing them. In this post I propose to look briefly at the obstacles to shareholder litigation against companies and their management.

As I mentioned in my first post, although the Company Law and the Securities Law provide that companies and their directors and officers have certain duties, the court system is not always willing to grant a private right of action if the duty is violated. Very often courts may take the view that the problem is one for administrative agencies to deal with. Sometimes the courts' reluctance to take cases is based not on a legal analysis of whether there exists a private right of action, but on a practical analysis of whether the court system has the capacity to handle such cases. Thus, from 2001 to 2003, the Supreme People's Court (SPC) issued three sets of rules instructing lower courts not to accept shareholder lawsuits under the Securities Law unless (a) the suit was for misleading disclosures, and (b) an administrative or criminal punishment had already been imposed on the defendant(s) for the act complained of. (The rules also provided a set of procedures for hearing such cases.) In effect, a disgruntled shareholder must get a key to the courthouse from a government body, and cannot sue at all for losses from insider trading or market manipulation, even though both are equally prohibited in the Securities Law.

The justification for the key-to-the-courthouse rule offered by the SPC was that this was favorable to plaintiffs: a previous finding against the defendants would reduce their evidentiary burden. I have discussed this rationale with a number of academics in China, and have never really gotten a satisfactory answer to my objection that that rationale justifies allowing plaintiffs to bring in a previous finding as evidence, but not requiring them to do so.

A few months ago I read an article in Caijing, a Chinese business magazine, stating that the "spirit'" of a recent SPC document meant that plaintiffs could now sue for insider trading and market manipulation, but the article did not mention the name or source of this document. I e-mailed the author requesting further details, but got no response. When I was in China in December, I questioned a securities litigator about it, and discovered that the article was referring to a speech by a particular SPC official in which he said that such lawsuits should now be allowed to go forward. Does a speech by an SPC official give standing where an official document says otherwise? I guess if local courts think it does, then it does.

More on barriers to litigation tomorrow.

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A recent discussion on the Chinalaw listserv has revealed a fascinating loophole in Chinese real property law: nowhere does it seem to contain a clear prohibition against trespassing. The relevant laws regarding state-prosecuted offenses don't seem to include anything like this; at most, one is forbidden from disturbing order at a workplace, but that doesn't turn on whether one is trespassing or not, and is not an offense against the employer's rights to a particular physical space. On the civil side, one could (if one wished) construct an anti-trespassing norm by combining various provisions in the Property Law: Art. 2, stating that rights in rem include the right to exclude, Art. 32, which says that a rightholder can sue for damages resulting from infringement of his rights, and Art. 35, which says that an aggrieved rightholder may request a court to eliminate an impairment of the right. But whether this amounts to an action against trespassing - in particular, to an action for ejectment, or an injunction against further trespass - doesn't seem clear. A Chinese scholar specializing in real estate law, in his contribution to this discussion, said it does not; according to him, the most Chinese law requires is that someone entering onto the property of another should "restrain [himself]", minimize damage, and compensate for any damage done.

The interesting question, of course, is why this should be so. My hunch is that it's connected to China's pre-reform economy, in which all important urban spaces were under the more or less direct control of a governmental or quasi-governmental entity with access to tools of physical coercion (i.e., people with clubs). Physically as well as politically, pre-reform China was a very closed society - workplaces and apartment buildings were often walled or fenced, with all entrances manned by guards. Trespassing would have been difficult to accomplish simply as a practical matter. Furthermore, much urban land was owned by the state (technically, all of it after 1982), and the particular way of understanding state ownership of land may have contributed. In the US, we have no problem saying that citizens can be trespassers on state-owned land, because the state owns land more or less just like any private party owns land. But in China, state ownership, sometimes called "ownership by the whole people" (the terms are explicitly said to be synonymous) is sometimes and for some purposes interpreted as direct ownership by the citizens of China. Obviously, this couldn't be true in any practical sense - you would need the consent of all joint owners to alienate, for example - but perhaps it's felt just enough to make a notion of trespassing unthinkable.

It's hard to believe - and to the best of my knowledge it's not true - that in China you can simply waltz into someone's living room (provided the door is unlocked) and make yourself comfortable provided you act with restraint and are willing to compensate for any damage you cause. But the legal basis for saying you can't is surprisingly obscure.

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Having taught the first-year property course for eight years and instructed my students in the "bundle of sticks" model of property rights, I was fascinated to run across the following Chinese property law case a couple of days ago. (For those who can read Chinese, it's here.) By way of background, China passed its first comprehensive statute governing rights in rem (the "Property Law") last year, and it came into effect in October. Although it did not (at least in my opinion) fundamentally revolutionize anything - contrary to some breathless reports, private property existed and was protected in China prior to Oct. 1, 2007 - in any case we are now starting to see cases in which courts look to it for guidance.

In the case in question, Husband (H) and Wife (W) divorced by agreement in 2005. Their agreement provided that the 2-bedroom apartment held in W's name (China has a community property regime, so the nominal owner is not necessarily important) should be divided, with ownership over the southern room to H and ownership over the northern room to W. By 2007, W had had second thoughts about this arrangement, and brought suit in January to have the agreement declared invalid. She sought full ownership of the apartment, with a payment to go to H representing the value of his interest.

The Beijing No. 1 Intermediate Court agreed. (I believe the judgment was issued after Oct. 1, and applied the Property Law as the rule of decision.) According to the court, while there can be joint ownership over the same thing, there cannot be separate ownership rights over the same thing, and an apartment is the smallest "thing" you can have in real property law; you can't subdivide it any further.

The news report of the case appends an explanation from the judge who decided it, but it's not very helpful - there's a hint that what's driving the decision is China's property registration system, which doesn't have the capacity to register ownership of separate rooms within an apartment unit. But one also gets the sense that the judge thinks it's just self-evident that you can't own rooms within an apartment; he says specifically that you are not allowed just to make up ownership interests at will.

Interestingly, though, this is precisely what you pretty much are allowed to do in the US; there is no elementary particle of property rights. In my last post, I talked about the way Chinese law often seems centered around the needs of officialdom. That may go some way toward explaining the different approach to property rights as well. The creation of property rights in the US is highly decentralized and contractual. China is simply not willing to let individuals have this kind of undisciplined power to create property rights that the state is then going to have to protect. The state wants more control over what its coercive machinery is going to be asked to do.

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Many thanks to Gordon for his kind introduction and for inviting me on as a guest blogger. I'm a regular reader of Conglomerate and it's an honor to be asked to join in.

My research interest is in modern Chinese legal institutions generally and corporate governance in particular; recently I've been looking not at the substantive rules of corporate governance, but at the institutions that would make those substantive rules matter, and the extent to which they exist in China.

One can't spend much time studying Chinese law without being struck by the tremendous gap between what the rules say and what actually happens. This goes beyond the usual law-on-the-books versus law-in-practice gap that one can find in any jurisdiction, where the gap is attributable to obsolescence, resource constraints, and political factors such as government unwillingness to enforce certain types of laws. In China it seems to arise sometimes from a different view of law altogether:
essentially a kind of didactic text that regulated parties are supposed to read and obey. If obedience is not forthcoming, the response is to blame the regulated parties for their willfulness. An alternative response would, of course, be to look at the enforcement structure provided by the regulations in question: do regulated parties have any reason to obey? But this response is relatively rare.

Thus, for example, the Chinese Company Law provides that joint-stock companies (more or less the equivalent of the Delaware corporation) shall have both a board of directors and a board of supervisors. The latter is supposed to keep an eye on the former. But it is elected by exactly the same body that elects the board (i.e., the shareholders) and, while it can ask questions of the directors or request explanations of certain acts, it has no real power to do anything if the answers aren't satisfactory. A recent revision to the Company Law (in 2005) gave it the power to call a shareholders' meeting, but that's about it.

Another example is the director's duty of care and loyalty. This is stated in one provision of the 2005 revised Company Law, but there is no right of action clearly attached to it. Where the law does not very clearly provide you with a right of action (and even in some cases where it does), Chinese courts are typically very unwilling to give you one.

This in turn stems from another feature of Chinese law: that it often seems to make sense more as a set of instructions to officials than as a rights-granting instrument. For example, one type of company under the Company Law may dispense with a board of directors if it is "relatively small" and has a "relatively small" number of shareholders. But the law provides no clue as to how we are to know what counts as "relatively small" in each case. If we think of the law as a recipe for entrepreneurs, it's bad drafting. But if we think of it as instructions to officials in the bureaucracy that handles corporate registrations, then it's easier to understand: it's telling them to make a discretionary judgment. The same thinking is behind regulations that look like private law but say that something or other "should normally" be done or "should in principle" be done.

One might reasonably ask, "But is that so different from US (or other Western) law? Surely we have vague terms such as 'due process' and 'reasonable' that we happily give to judges, juries, or administrative agencies to interpret." This is not a bad point. I think the difference, though, is in the fact that in the US system, we now have a pretty good idea of who has the power to interpret what; when people draft legislation, they could probably readily tell you which body would be interpreting which term and under which principles. Very few of these matters are well worked out in the Chinese legal system. Legislation will always have problems, but the courts have very little power and prestige, and thus aren't a good institutional solution to these problems. As a result, while all legal systems generate uncertainty and contradiction, China's is unusual in not having well-understood techniques for resolving that uncertainty and contradiction.

The bottom line is that when one hears that Chinese corporate law requires such-and-such or imposes such-and-such a duty, one has to ask whether there's any reason to think that this alleged requirement or duty is at all meaningful. One doesn't have to be a card-carrying Holmesian realist to wonder whether a duty that is in substance wholly hortatory should really count, and be reported, as a legal duty just like the legal duty to drive carefully, refrain from embezzlement, etc.

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Last week at the Law & Society Annual Meeting in Berlin, I attended/participated in three panels on comparative corporate governance, which I had organized with John Ohnesorge (Wisconsin) and Andreas Engert (Munich). Our goal was to showcase some of the new generation of European and Asian corporate governance scholars, and the results were impressive.

One paper that had everyone buzzing was a new study by John Armour, Simon Deakin, Priya Lele, and Mathias Siems with the unsexy title, "How Legal Rules Evolve: Evidence from Panel Data." If you are interested in the LLSV literature, you will want to keep an eye out for this paper, which is not available on the internet, yet. Here is the abstract:

Much attention has been devoted in recent literature to the claim that a country’s ‘legal origin’ may make a difference to its pattern of financial development and more generally to its economic growth path. Proponents of this view assert that the ‘family’ within which a country’s legal system originated—be it common law, or one of the varieties of civil law—has a significant impact upon the quality of its legal protection of shareholders, which in turn impacts upon economic growth, through the channel of firms’ access to external finance. Complementary studies of creditors' rights and labour regulation have buttressed the core claim that different legal families have different dynamic properties. Specifically, common law systems are thought to be better able to respond to the changing needs of a market economy than are civilian systems. This literature has, however, largely been based upon cross-sectional studies of the quality of corporate, insolvency and labour law at particular points in the late 1990s. In this paper, we report preliminary findings based on newly constructed indices which track legal change over time in the areas of shareholder, creditor and worker protection. The indices cover five systems for the period 1970-2005: three 'parent' systems, the UK, France and Germany; the world’s most developed economy, the US; and its largest democracy, India. The results cast doubt on the legal origin hypothesis in so far as they show that civil law systems have seen substantial increases in shareholder protection over the period in question, and cannot be accurately characterised as less shareholder-friendly than common law ones. The results also show that the pattern of change differs depending on the area which is being examined, with creditor rights and labour rights, for example, demonstrating much more divergence and heterogeneity than shareholder rights. The results for labour rights are more consistent with the legal origin claim than in the other two cases, but this overall result conceals significant diversity within the two ‘legal families’, with different countries relying on different institutional mechanisms to regulate labour. Finally, we found that until the late 1980s the law of the five countries was diverging but that in the last 10-15 years there has been some convergence in the legal protection of shareholders, creditors and employees.

By highlighting this paper, I don't want to cheat the others that were presented. They were many and varied, and I immensely enjoyed them. My motives for helping to organize these sessions were entirely selfish: I wanted to meet the participants and learn from them. Since 1990 or so, comparative corporate governance scholarship has been on the rise in the US. We are familiar with the work of American scholars like Mark Roe, Ron Gilson, and Bernie Black, as well as some prominent scholars from outside the US (Theodor Baums, Katherina Pistor, Klaus Hopt, Hideki Kanda, Paul Davies, etc.), but my sense is that comparative corporate governance has really been gaining some steam over the past few years.

Attendance at these sessions was unusually strong for LSA. In the first session, the room was packed -- not a single empty seat. (36 chairs ... I counted.) And many people turned away at the door. The later sessions were also well attended, in part because the participants in the panels viewed the sessions as a "conference within a conference," but also because many other people were interested. I am eager to dig deeper into comparative corporate governance over the coming years, and I appreciate all those who taught me something over the past few days.

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. . . until I went to Ethiopia:

1.    The world's highest capital city is LaPaz, at 11,913 feet above sea level.  The world's second highest capital city is Quito, at 9,350 feet.  These elevations make the mile-high city seem like small beer, right?  These capitals dwarf even the peaks of many ski resorts in the US.  So why do these factoids matter for Ethiopia?  Well . . .

2.    The world's third highest capital city is Addis Ababa, elevation c. 8,000 feet.  At least according to local lore, this ranking is accurate.  The city's elevation is important for at least two reasons. 

First, the elevation means mild weather all year round and no mosquitos.  During my short stay (the last week of June), it was cooler in Addis than in Atlanta.  No mosquitos also means no malaria, no yellow fever.  So while I got the full panel of vaccinations before I left (hep A, polio, typhoid, meningitis, DPT, as well as yellow fever), at least the weather was mild, and mosquitoes and the mosquito-borne diseases were not a worry.

Second, the elevation in Addis, according to local sports fans, helps explain Ethiopian dominance in distance running.  Many (most?) of Ethiopia's elite runners train in Addis, where the thin air makes for superior conditioning.  When they race at locales closer to sea level, the advantage is apparently similar to blood doping (which increases red blood cell counts to improve performance).

3.    Addis has a growing Chinese population!  My first night there, I'm sitting in the lobby of my hotel having a beverage when I hear Mandarin being spoken behind me.  Two Chinese fellows had just walked in, and they sat down at the next table.  We started chatting, and it turns out they work for a Chinese engineering/ construction company that has a big road project going on in Addis.  One of the fellows said he'll probably be staying in Addis for a couple of years until the project finished. 

Addis is clearly booming with construction projects--buildings and roads.  Apparently all the roads are being built by Chinese contractors.  Both cabbies and my lawyer companions at the Ministry of Justice confirmed that Chinese firms are the dominant players on infrastructure projects in Addis, and that apparently Chinese firms are involved in construction all over Africa.  One night, I also noticed a table of Chinese expats at one of the nicer Italian restaurants in town.  I guess I knew in the abstract that China always saw potential strategic partners in Africa.   It was interesting to actually see Chinese involvement in the region.

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I'm just back from a week in Ethiopia, where I consulted with the Ministry of Justice on reform of Ethiopia's Commercial Code.  (Yes, you can actually read the Commercial Code online.  This did not surprise me before I left, but seems much more surprising now that I have spent time there, where "broadband" is not so broad.  More on that later . . .).  My short stay there--my first time in Africa--left me with many impressions about business, law, economics, and society, which I am still processing.  I expect I'll blog periodically about Ethiopia over the next few weeks as I sort out my thoughts (and inflict them on you).  That's me there on the left, with lawyers from the Ministry of Justice--warm and gracious hosts to a person--and my friend Claire Dickerson from Rutgers Law, who got me involved in the project.

The Commercial Code incorporates a lot of stuff, including business organization law and bankruptcy law.  The Ministry of Justice and foreign commercial interests are vitally interested in modernizing commercial law--and with it, the economy.  The Minister himself showed up on the first day of our meetings, along with the French ambassador.  The current Code was enacted in 1960 during the reign of Emperor Haile Selassie.  Since then, Ethiopia has been through coups, communism, and contested elections. The current government has committed to privatizing the socialist economy it inherited.

A modern commercial code, of course, is but one (probably not the first) factor in successful development of the economy.  The country is quite poor:  over 80% of the population survive by subsistence farming and livestock grazing.  The capital Addis Ababa feels like a typical third-world capital, in some ways more so.  Traffic is not as bad as Bangkok or Jakarta or New Delhi, but pollution from the cars is probably worse.  Few of the autos seemed to use tailpipes, as the smell of exhaust in the passenger compartment was quite strong in every car I rode in.  There is more livestock herding through city streets than I've ever encountered.

One striking aspect of Ethiopia--that everyone from cab drivers to Ministry lawyers comment on--is its ethnic fragmentation.  A political compromise in 1995 formalized a system of ethnic federalism.  The country is divided into nine ethnically-based administrative regions, each of which has its own official language.  Court proceedings, for example, are conducted in different languages in each region.  Each person's national ID card specifies her ethnic group.  The dominant language in Addis is Amharic, but any attempt to promote a national language--as Mao did by mandating Mandarin education in primary school in China--is apparently fraught with political peril.  Eritrea of course seceded in '93, and separatist movements in other regions are active.

The implications of this ethnic-political structure are of course far-reaching.  Forgive the reduction, but to the American-trained lawyer-academic interested in economic development, this feels like one big transaction cost. Besides language and ethnic fragmentation to make commercial interaction more difficult internally, the country also relies on the Julian calendar and a system of time keeping based on sunrise and sunset.  For example, "one" o-clock in the morning is one hour after sunrise (or our 7 AM).  These latter of course may simply be artifacts--and not causes--of an incomplete engagement with external commercial activity.  On the whole, though, the circumstances suggest that economic progress will be slow.  Commercial law reform is probably necessary, but hardly sufficient.

I met a doctor on the flight home who spends several months of each summer leading US medical teams in Africa doing spot medical relief all over the continent.  He captured my sentiments pretty well when he described his sense of an overwhelming task, where one has to be content with the small steps one can effect in a short time. . . .

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Yesterday at the Law & Entrepreneurship Retreat, Darian Ibrahim and I outlined a new project in which we will be examining the connection between law and various fundamental concepts in entrepreneurial studies. One of the participants in the Retreat suggested that we look at the "rule of law" literature that has become so prominent in the reform efforts of the World Bank. Today I noticed a new paper by Ray Fisman and Edward Miguel entitled Cultures of Corruption: Evidence from Diplomatic Parking Tickets, which bears on that debate. Here is the abstract:

Corruption is believed to be a major factor impeding economic development, but the importance of legal enforcement versus cultural norms in controlling corruption is poorly understood. To disentangle these two factors, we exploit a natural experiment, the stationing of thousands of diplomats from around the world in New York City. Diplomatic immunity means there was essentially zero legal enforcement of diplomatic parking violations, allowing us to examine the role of cultural norms alone. This generates a revealed preference measure of government officials’ corruption based on real-world behavior taking place in the same setting. We find strong persistence in corruption norms: diplomats from high corruption countries (based on existing survey-based indices) have significantly more parking violations, and these differences persist over time. In a second main result, officials from countries that survey evidence indicates have less favorable popular views of the United States commit significantly more parking violations, providing non-laboratory evidence on sentiment in economic decisionmaking. Taken together, factors other than legal enforcement appear to be important determinants of corruption.

HT ELS Blog.

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Today Judge Dennis Davis of the High Court of Cape Town, South Africa spoke at Maryland about the process of drafting South Africa’s new Corporate Code.  For the past several years, South Africa has been in the process of revising its corporate code to bring South Africa’s corporate governance standards in line with the rest of the world.  Judge Davis, who has been an integral part of that process, spoke about how important American law and lawyers were to that process.  Indeed, South Africa’s code incorporates many principles, concepts, and in some cases provisions, of the Model Business Corporation Act.  And Judge Davis noted that the Act has played a significant role in corporate law reform within many developing countries.  Also, several American lawyers such as Jim Hanks of Venable and John Olson of Gibson played a critical role in helping to draft South Africa’s code.  Jim Hanks, who spoke with Judge Davis, reminded the audience that there is, as he called it, a “healthy appetite for the American experience” even as it relates to corporate law.  As a result, many countries around the world continue to look to our corporate governance system as a model for revisions in their own law.  In the wake of governance and other scandals, it is easy to forget that fact as well as the fact that our system (though certainly flawed) has many virtues.  However, both Judge Davis and Jim Hanks emphasized the importance of ensuring that the American system is not transplanted wholesale.  Instead, while corporate codes in other countries should borrow from the American system, such codes must be adapted to reflect both the social and economic realities of emerging countries.  Hence, while South Africa’s corporate code may rely on the Model Act, it does not mimic the Act.  The public comment period for the code has ended and there is high hope that it will be passed into law.  After that, Judge Davis indicates that there will continue to be a role for American lawyers to help interpret and guide the new code’s implementation.  That is great news for me since I have been looking for a reason to get back to South Africa.

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Let's say that you have a job that allows you to travel during the summer. You do most of your work online, so as long as you have an internet connection, you can be anywhere. And let's say that you  love all of Europe, but you prefer to focus on one country per summer, rather than hopping around.

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From its inception, the (non) application of SOX to foreign issuers has been controversial.  Now the whistleblower protections of SOX have come into focus as another avenue for crossborder tensions.  The ABA Journal has a nice summary of current issues.  Europe, it turns out, is much less enamored of whistleblowers than we are in the States.  While "Americans like to elevate whistle-blowers to near folk-here status, from Daniel Ellsberg . . . to Sherron Watkins," in Europe, whistleblowers are often thought of as informants, as rats.  in Germany, "the term  term most likely conjures up memories of the Gestapo . . . .  In France, the term evokes images of the Vichy regime’s collaboration with the Nazis and of neighbors ratting out one another." 

No wonder that the EU has had some trouble coming to terms with the application of the new Sox whistleblower provisions to its issuers crosslisted in the US--especially the requirement that issuers establish procedures to allow employees to file internal whistleblowing complaints anonymously.  Europeans are apparently more concerned about the privacy and reputation of the accused.  "[W]hile the Americans are most concerned with protecting whistle-blowers to ensure market integrity, Europeans place a higher premium on guarding personal reputations of targets of complaints, which sometimes arise out of spite, revenge or other suspect motives."

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In a series of articles beginning in 1996, economists Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny ("LLSV") created a sensation among legal academics and finance scholars by proposing that "countries with poorer investor protections, measured by both the character of legal rules and the quality of law enforcement, have smaller and narrower capital markets." The initial excitement among legal scholars waned quickly when we read LLSV and found the methodology wanting. But finance scholars have not abandoned the project, and recent work in the area has made substantial improvements.

My colleague John Ohnesorge just alerted me to the latest paper on this topic, which comes from a young German legal scholar. Here is the abstract from Holger Spamann, On the Insignificance and/or Endogeneity of La Porta et al.’s “Anti-Director Rights Index” Under Consistent Coding (working paper March 2006):

I re-code the “Antidirector Rights Index” (ADRI) of shareholder protection rules from La Porta et al. 1998 for 46 countries in 1997 and 2005 with the help of local lawyers. My emphasis is on consistent coding; I do not change the original variable definitions. Consistently coded ADRI values are neither distributed with significant differences between Common and Civil Law countries, nor predictive of stock market outcomes. The revision of the variable definitions in Djankov et al. 2005 salvages some of the original results, but reinforces severe endogeneity concerns regarding the index components that drive the remaining significant results. I review the other index components and conclude that the ADRI is unlikely to be a valid measure of shareholder protection. Results derived with the ADRI in the literature may have to be revisited. Along the way, I develop some general guidelines for consistent coding.

I have read only the first part of the paper, but Spamann already displays much greater understanding for the nuances of law than LLSV. (That's not surprising, of course, since Spamann is getting his SJD at Harvard.) Here is one example that appears early in the paper: "Perhaps the most basic question for coding of legal variables like the ADRI is whether only mandatory rules, or all default rules, or even optional rules should be counted." This is obvious to lawyers, but was not explicit in LLSV.

If you are interested in LLSV and its progeny, this paper looks to be worth a read.

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